For most investors, neither an aggressive investment strategy nor an overly conservative one works. Instead, a vast majority of individuals may be willing to take some degree of risk if it increases the potential to earn significantly higher returns. To achieve this goal, a balanced investment strategy is essential.
In this article, we explore the meaning of this strategy, its benefits and limitations and how you can implement it.
What is a balanced investment strategy?
A balanced investment strategy is a technique that aims to balance risks and returns. To create a balanced investment portfolio, you typically need to combine high-risk high-return assets like equity stocks with stabler investment avenues like bonds and other debt instruments. Some balanced investment portfolios may also allocate a small portion of the capital to money market instruments and cash equivalents to ensure liquidity.
Understanding the balanced investment approach
The primary aim of this approach is to balance the goals of capital preservation and capital growth. To ensure capital preservation, balanced investments focus on safe and stable assets like government bonds, corporate bonds and other fixed-income securities. Short-term money market instruments like treasury bills (T-bills), certificates of deposit (CDs) and commercial papers (CPs) also help meet this goal. These investments help preserve the investor’s capital, even if it means the scope for growth is low.
These safer investments are balanced by more aggressive assets like equity stocks. Depending on how much risk the investor can afford to take, a balanced investment portfolio may include safer stocks like those of blue-chip companies or riskier small-cap stocks. Equity mutual funds can also be included to add exposure to market-linked investments and simultaneously benefit from the expert fund management of fund managers.
The key benefits of a balanced investment strategy
A balanced investment strategy offers several benefits to investors, such as the following:
- Risk reduction: By spreading your capital across different asset classes like stocks and bonds, a balanced investment strategy reduces the risk associated with market fluctuations.
- Consistent returns: This strategy also aims to provide more consistent returns over time. While it may not capture the highest returns in the market, it also avoids the lowest lows.
- Flexibility: A balanced investment portfolio can easily be adjusted according to changing market conditions or evolving life goals. For instance, you adjust the portfolio to prioritise capital preservation as you approach the retirement age.
- Income generation: Bonds and other fixed-income assets in a balanced investment portfolio can offer regular income to the investor. This is particularly beneficial during periods of market downturns.
Also read: How do mutual funds work
An example of a balanced investment strategy
Understanding how a balanced investment strategy works is easier with the help of an example. Here is a hypothetical scenario that can help you comprehend the concept better.
Assume you are a 30-year-old individual who is planning on accumulating a large enough corpus to help you retire comfortably. You plan to retire at 60 years of age, which gives you a total investment tenure of 30 years. Your tolerance for risk, on the other hand, is moderate.
Although you can afford to take a slightly more aggressive approach to investing, you prefer to equally focus on capital preservation. Therefore, you opt for a 60:40 split, where 60% of your investment capital is invested in stocks, and the remaining 40% is invested in debt instruments.
Among the 60% stock investments, you choose to invest primarily in mid-cap companies to maximise wealth creation. Meanwhile, you allocate the remaining 40% of your investment capital that you set aside for investing in debt instruments towards government securities and corporate bonds with exceptional credit ratings.
Now, by leaning slightly towards stocks, you essentially give your portfolio the advantage of generating high returns when the markets are favourable. And when the markets are going through a rough patch, your debt investments will step in and protect your capital from eroding.
Also read: Short term vs long term mutual funds
Balanced investment strategy vs capital preservation
A balanced investment strategy and capital preservation are two different approaches to investing.
As you have already seen, a balanced strategy aims to focus equally on both wealth creation as well as capital protection. Such a strategy involves investing in a combination of equity and debt instruments to achieve a middle ground between growth and stability. A balanced investment strategy could be an ideal approach for investors willing to accept a certain level of risk in pursuit of higher returns.
Capital preservation, on the other hand, focuses only on protecting your principal investments even at the cost of wealth creation. This approach involves investing in low-risk investment options with little to no risk of default like high-quality bonds, certificates of deposit, money market funds, and government securities. Since the approach prioritises safety over growth, it is a highly conservative investment strategy and is more suitable for investors who have a very low tolerance for risk.
Ultimately, the choice between these approaches depends on factors, such as the investor's age, financial goals, risk tolerance, and time horizon.
What are balanced funds?
Balanced funds, also known as hybrid funds, are a type of mutual fund that invests in a mix of both equity stocks and debt instruments. Aligned with the principles of a balanced investment strategy, these funds aim to achieve a middle ground between growth and capital preservation.
One of the many advantages of balanced funds is that investors can achieve proper diversification across asset classes without having to manage individual investments themselves. Additionally, since these funds are actively managed by fund managers, investors also benefit from professional management.
In India, there are multiple types of balanced funds. For instance, there are equity-oriented funds, which tend to lean more towards equity than debt. Then, there are debt-oriented funds, which lean more towards debt instruments than equity. Finally, there are balanced advantage funds, which dynamically change the asset allocation mix between equity and debt depending on the prevailing market conditions.
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What are target-date funds?
Target-date funds are a type of dynamically adjusting mutual funds. However, unlike most dynamic funds, changes to the asset allocation mix are not dependent on the prevailing market conditions. Instead, the asset allocation is automatically adjusted over time.
Target-date funds usually start with a higher allocation to equity stocks compared to debt instruments. This is done to maximise the wealth-creation potential of the fund. Over time, as the funds approach a certain specific target date, the asset allocation gradually shifts towards debt and money market instruments, becoming increasingly conservative. This is done to reduce risk and provide the funds with more stability.
Target-date funds are ideal for investors who plan to create wealth just in time for their retirement.
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Tips to implement a balanced investment strategy
To tap into the benefits of a balanced investment strategy as outlined above, you can implement the following tips.
- Understand your risk tolerance to get a better idea of how much risk you can tolerate.
- Assess your financial goals to obtain clarity on the amount of corpus or the returns required.
- Choose a diverse mix of investments to meet your financial goals.
- Include index funds and Exchange-Traded Funds (ETFs) if you prefer a passive investment approach.
- Monitor your balanced portfolio regularly to assess if it remains aligned with your risk-return preferences.
- Rebalance your portfolio if required to ensure that your preferred asset allocation is maintained.
- Consider the effect of inflation on the debt component of your balanced investment portfolio.
- Seek professional advice if you need further help with your balanced investment strategy.
The limitations of a balanced investment strategy
Before adopting a balanced investment approach, you must also be aware of the method’s limitations, which include the following:
- Capped growth: The overall growth prospects in this type of portfolio are limited because a portion of the capital is allocated to bonds and low-risk assets with low growth potential.
- Inflation risk: The fixed-income portion of a balanced portfolio may be exposed to inflation risk, especially in a low-interest rate environment. This may reduce the purchasing power over time.
- Market timing issues: Striking a balance between stocks and bonds assumes that these two asset classes may move in the same direction. However, sometimes, both bonds and stocks may dip in value simultaneously.
Conclusion
To adopt a balanced investment strategy, you can choose from a mix of equity-oriented and debt instruments. Another easier alternative is to consider investing in balanced mutual funds. These schemes invest in a mix of stocks and bonds, offering you the benefit of instant diversification.
On the Bajaj Finserv Mutual Fund Platform, you can find balanced funds as well as other different mutual fund schemes. With over 1,000 funds to choose from, you have no dearth of choice. You can compare mutual funds and start a SIP investment in the funds that align with your balanced investment strategy.
